A company's general counsel calls her outside counsel, saying that she fears a U.S. Securities and Exchange Commission investigation of her company. An employee committed wrongdoing six years ago, she says, and although the employee apparently took no particular action to cover it up, nobody discovered the wrongdoing until today.
Her outside counsel might tell her not to worry: The statute of limitations for SEC actions is five years, so any SEC action seeking civil penalties is time-barred.
Before the decision by the U.S. Court of Appeals for the Second Circuit in SEC v. Gabelli, her outside counsel would have been right.
If the U.S. Supreme Court affirms the Second Circuit's expansive interpretation of the statute of limitations applicable to the SEC, the SEC will be empowered to commence actions seeking civil penalties for as long as it failed to "discover" alleged misconduct, no matter how ancient the misconduct is.
Moreover, while the impact of Gabelli on SEC actions is obvious, the statute in question applies to all federal agency actions seeking civil penalties, unless Congress specifically states otherwise. Thus, the potential fallout is far broader.
In SEC v. Gabelli, 653 F.3d 49 (2d Cir. 2011), the Second Circuit considered when an action "accrues" under 28 U.S.C. 2462, which states that, except as otherwise provided by Congress, administrative agencies have five years from "the date when the claim first accrued" to commence any action seeking civil fines, penalties, or forfeitures.
In Gabelli, the allegedly wrongful acts ended in August 2002. The SEC filed the civil action in April 2008, claiming to have discovered the acts only in late 2003. If the claim accrued in 2002, when the acts took place, the claim was time-barred. However, if the claim accrued when the SEC "discovered" the acts in 2003, the limitations period had not yet expired.
The Second Circuit held that because the allegations sounded in fraud, the discovery rule delays accrual of the cause of action "until the plaintiff has 'discovered' it, or in the exercise of due diligence, should have discovered it." Even though "Section 2642 does not expressly state a discovery rule…for claims that sound in fraud[,] a discovery rule is read into the relevant statute of limitations." Thus, the court determined, the SEC has five years from its discovery of the wrongdoing to initiate the action.
The Second Circuit distinguished the discovery rule, which deals with claims that "by their very nature involve self-concealing conduct," from the well-established fraudulent-concealment doctrine, under which claims are equitably tolled when "the defendant took specific steps to conceal her activities from the plaintiff." But fraudulent concealment is not at issue before the Supreme Court only the "discovery" rule.
THE DISCOVERY RULE AND THE SEC
The discovery rule sensibly applies in cases brought by private plaintiffs, who are not charged with enforcing laws or performing the investigatory work necessary to do so. Private citizens need not live their lives constantly checking whether any person, anywhere, has caused them harm about which they might not yet know.
But it is another matter to allow the discovery rule to be the default for government action. Administrative agencies have affirmative obligations to provide oversight and regulation. As the SEC describes, its mission "is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." It cannot do so without diligently overseeing and investigating those markets.
The Second Circuit's reading of Section 2642 would give the SEC a free pass. Without a looming limitations period, the SEC could ignore warning signs of wrongdoing, knowing that if it later "discovers" the wrongdoing, it will then have five more years to decide whether to commence an action. Such a rule risks incentivizing the SEC not to investigate a matter until it is good and ready. In the wake of Bernie Madoff, the mortgage-backed securities fraud settlements, insider trading scandals and fallout from the financial crisis of 2007-2008, few would argue that a slower, less watchful SEC should be a national priority.
Allowing the SEC a "discovery" rule also would be acutely unfair to individuals and organizations in the securities industry, for whom there could never be any finality.